New ruling on pension fund reporting has vast impact

A change in accounting and actuarial standards usually is only big news to Excel Jedi masters.

A new ruling by the Government Accounting Standards Board, though, is likely to have a broader impact. It could affect the cost of borrowing by cities and school districts in Ohio and across the country.

GASB is the independent organization that defines accounting and financial reporting standards for public agencies. It is implementing two changes for fiscal year 2015 that will require public agencies, for the first time, to disclose on their annual balance sheets their share of any shortfalls in employee pension funds.

“We're concerned with how (the new information on financial reports) will be used,” said Lisa Morris, executive director of the Ohio State Employee Retirement System, one of Ohio's five major pension funds.

That's because the new reporting requirements don't change the financial condition of any government agency in Ohio directly. The reporting changes are designed to make the public and the municipal bond market more aware of what could be a long-term problem that could affect the way bond rating agencies and investors appraise the financial condition of cities and school districts. That, in turn, could make it more difficult — or at least more expensive — for them to borrow money for new schools, roads or swimming pools.

The GASB changes are a response to the decline in the value of pension-fund stock holdings resulting from the stock market's downward trajectory over much of the last decade and the prospect that those stock portfolios won't recover fast enough to cover future pension obligations.

The pension fund world has also been rocked by Detroit's bankruptcy and its impact on that city's pension funds. At the same time, a November 2012 report by Morningstar Inc., a financial reporting service, found pension funds in 21 states that Morningstar considered financially unsound. Ohio's pension funds are not in that group, though they do have a level of what's called “unfunded liability.”

Because local governments don't run their own pension funds, until now, the municipal bond market hasn't known how much pension debt the communities might be on the hook for. Now, every city and school board's share of the state pension debt will appear on their financial statements.

Ohio pension funds pay benefits from past contributions by employers and employees and from investment income. State law sets the employer's contribution at 14% of salary, while employees contribute 10% of salary.

Because payouts to retirees will stretch out over decades, a pension fund does not need to have 100% of its future liabilities on hand. Instead, a typical pension plan may have assets on hand that will equal to 70% to 80% of its future needs, with the expectation that future investment returns will cover the rest. The sour investment environment since the recession, though, has pushed some public pension funds around the country — but not in Ohio — below a comfortable cash-on-hand ratio.

Now, the amount of those unfunded liabilities will be prominently displayed on local financial statements for the first time, not just on the pension's fund's balance sheet.

"It will impact everybody'

State Auditor Dave Yost has been touring the state offering local finance directors advice on how to make sure their financial statements are accurately compiled. A forum in Parma April 17 drew about 250 finance officers.

Yost explained to the audience how the impact could be shouldered by local governments, their employees or by shifts of spending from other local services to cover the cost of pensions.

If future investments don't produce the anticipated return, typically 7.75% annually, a pension fund could find itself lacking the cash to be able to issue monthly pension checks. If that happens, it's likely that the state would change the law and boost the pension contributions required of the public employers, the employees or both. So, because the municipal bond market takes the long view, showing the unfunded pension liabilities on local financial statements will emphasize that the city or school district could someday end up with a big debt.

Until the 2015 financial statements are reported, Ohio public agencies won't know how much they might be on the hook for. But one study of 2009 pension shortfalls in 61 cities found more than $100 billion in unfunded liabilities. The study, by the Pew Charitable Trust, did not include Cleveland but reported that Columbus had unfunded liabilities of nearly $1.4 billion.

Matthew Rubino, finance director of Shaker Heights, who attended the Parma briefing, said, “No one is thrilled about it, but we understand the logic behind it. It will impact everybody.”

More information helps

One rating agency already has changed its ratings analysis to account for these unfunded pension liabilities.

“We identified last year a series of local government ratings that were outliers,” said Thomas Aaron, a public finance analyst for Moody's Investor Service. “We did have a number of Ohio school districts on that list.”

As a result, seven southern and central Ohio school districts have had their credit ratings downgraded. The other rating agencies — Standard & Poor's Financial Services LLC and Fitch Ratings Inc. — could add to that list as they review future financial statements.

Tim Offtermatt, an investment banker with the Cleveland office of Stifel Financial Corp. who specializes in public finance, thinks the new reporting requirements could help Ohio communities in the municipal market. He believes that some potential investors have been shying away from municipal bonds of even well-funded cities because they read about the financial problems in Detroit and other cities.

“Anything that's done (because of the GASB reporting changes) that adds clarity to a state or local government's financial situation is helpful,” he said. “If investors don't have the data in audited financial statements, they react to newspaper headlines and they don't buy (municipal bonds). The additional information will be good for investors.”

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